Digging out the ‘real’ from the real estate industry

Guest post by Ramesh N, GM - Finance & Accounts, Mahaveer Group

Let’s closely examine the present status of the country’s real estate industry. India has become the world’s fastest growing major economy at 7.6% outpacing China last year. Real estate industry’s performance is close to 2009 levels even though our economy is doing well. Recently real estate companies are facing 50% to 60% drop in the sales volume and they are facing difficulties in even servicing their loans and funding for the construction activities.

This sales volume decline of the real estate industry is in direct proportion to the drop in the job creation, employment generation in eight sectors slowing to a seven-year low in 2015, as per the below report from the labour bureau.

Employment generation in the last seven years across eight sectors of the economy — textiles, leather, metal, automobiles, gems and jewellery, transport, information technology and handloom.

Bengaluru Real Estate Sector

Present status of this slow down is on account of the IT industry, which is a major contributor towards the Bengaluru real estate sector. Slow down in the recruitments from the IT industry and their single digit salary increments has turned down the market sentiments. Due to a global economic slowdown the IT industry’s growth has been effected and their recruitments for the financial year 2015 have dropped by 24%; during this period recruitment of a few companies was down by more than 70%. Nasscom has lowered its 2016-17 growth estimates for the IT industry, so real estate sector in Bengaluru may not see immediate recovery in this year.

A major factor for turning down the sentiment is that employed end users are worried about their job security and not getting enough increments to take a call on their property purchase decision. On the other side for investors the return on investment is the prime concern as many projects are selling at launch prices even after 2-3 years of launch.

Sale of apartments will stand apart, unlike any other product, where you can control the price of the product. If it does not sell, the cost of the product can be reduced to create a demand in the market. If the builder reduces the prices to sell a product faster, existing booked units may get cancelled, so builders are in a fix. Besides, builders need to build an entire tower irrespective of number of units sold in that tower and also needs to invest upfront for acquisition of complete land and approvals. So he leverages to the extreme due to his higher working capital requirement. This adds to the pressure over the builder during the industry slowdown.

Why a Real Estate Act?

Our Government wants to regulate the real estate industry as this is the second largest employment generator after agriculture in India. The real estate industry has forward and backward linkages with more than 265 ancillary industries. It also contributes 8% directly towards GDP and the indirect contribution will be much more than that.

As the builders are facing decelerating sales and cash flow issues, they are delaying the project completion. Hence, the customers are running from pillar to post to get their homes delivered as there is no appropriate forum to enforce their rights, and they are paying interest on their housing loans for an indefinite period and for the fault of the builder.

To protect the interest of the customers and to make builders responsible for their acts, the Real Estate (Regulation and Development) Act, 2016, been enacted.

How will this Act affect the builders?

A builder has to deposit customer collection into a separate escrow account and it can be drawn for the sole purpose of construction (Real Estate Regulatory authority will be the authorised signatory for the escrow bank account). The question that arises is ‘what happens to the money for servicing the loan borrowed?’ Looks like the builder may not be able to borrow money for construction and he needs to depend upon only customer advances. This may discourage private equity players from participating in the real estate activities. In turn, the real estate activities may retard and this may further drag the entire economy.

Builders can sell units only after obtaining all the approvals and NOCs. So they need to invest money for land purchase, approvals and for construction up to the plinth level.

Compliance under this act is so knotty that most of the small scale developers who cannot build as per plan, those who may not be able to deliver in time and the ones who cannot get occupancy certificate may vanish from the real estate industry, which is good for the leading builders. This may further curtail real estate industry and may affect economy from lack of healthier competition.

Plus, GST may further spoil the real estate industry as cost of apartment may go up by 10% as indirectly the excise duty will be pushed till the end user (GST, which includes excise duty will be charged on the gross margin of the builder, may be an additional cost to the end user).

The penalties under this Act are so stringent that each violation will cost the builder 5% of the total project cost. A couple of violations may be sufficient to lose an entire project profit to the penalties.

Conclusion:

Real Estate Act is going to bring in transparency from the builder and the customer will have a forum for faster disputes redressal. So it is going to help real estate customers to a great extent. This Act is going to create serious repercussions on the builders in the near future.

My recent book, Pragmatism of Real Estate Act, analyses the Real Estate (Regulation & Development) Act, 2016 and brings home the fact that even during the lows of the real estate industry a new skyscraper will see light of the day, every day. The best investment on earth is earth! To grab a copy of the book, click here.